LIC  UTILITY  BONDS 


icts 


Regarding  Their  Issue  and  Their  Security 


By  Frederick  Lownhaupt 


PUBLIC  UTILITY  BONDS 

FACTS  REGARDING  THEIR  ISSUE  AND 
THEIR  SECURITY 


BY 

FREDERICK  LOWNHAUPT 
Author  of  “Investment  Bonds” 


BOOKLET  NO.  2 OF  A SERIES  ON  BONDS 

See  Page  4 for  other  title* 


V. 

§ 


MOODY’S  MAGAZINE 

NEW  YORK,  N.  Y. 


Copyright,  1910 

BY 

A.  W.  Ferrin 


iu.  e, 

L^54h 

>jr.  t, 


CONTENTS 


Franchise  an  Important  Matter 
Franchise  and  Monopoly 

Geographical  and  Commercial 
Considerations 

Physical  Valuation  of  Plant 

Depreciation 

Contingencies 

Good  Record  of  Bonds 

Capitalization  of  Utilities  . 

Earnings  and  Expenses 

Utilities  Well  Established  . 


6 

7 

9 

10 

11 

12 

12 

13 

14 

15 


A SERIES  OF  BOOKLETS 
Treating  The  Subject  of  Bonds 

in  an  instructive  and  popular  manner 


Booklet  No.  T-Railroad  Bonds. 
Booklet  No.  2--Public  Utility  Bonds. 
Booklet  No.  3--Industrial  Bonds. 
Booklet  No.  4 Municipal  Bonds. 
Booklet  No.  5--Irrigation  Bonds. 
Booklet  No.  6--Timber  Bonds. 


PRICE  TEN  CENTS  EACH 


MOODY’S  MAGAZINE 
35  NASSAU  STREET 

NEW  YORK,  N.  Y. 


PUBLIC  UTILITY  BONDS 


THE  group  of  corporations  known  as  Pub- 
lic Utility  or  Public  Service  corpora- 
tions is  composed  of  a number  of  com- 
panies of  varied  activities.  Principal 
among  them  are  street  railways,  gas,  electric 
light,  water  and  telephone  companies.  In  the 
general  acceptance  of  the  term  "public  utility,” 
the  telephone  companies  are  included,  although 
they  are  often  not  regarded  as  belonging  to 
this  class  of  corporations.  Street  railways  and 
thdse  other  electric  railways  operating  between 
two  cities  or  touching  several  important  towns 
are  known  as  the  tractions,  although  those 
lines  not  entirely  located  within  the  boundaries 
of  a city  but  running  from  one  city  to  another 
take  on  a somewhat  special  character.  In  a 
word,  public  utility  corporations  are  those 
which  minister  to  the  local  necessities  of  peo- 
ple, and  which  have  become  indispensable 
through  increase  of  population  and  demand  for 
conveniences.  A distinguishing  characteristic 
is,  therefore,  suggested  in  their  intimate  rela- 
5 


tion  to  public  welfare.  From  the  nature  of  the 
services  they  perform  one  banking  house  has 
aptly  termed  them  “Public  Necessity  Corpora- 
tions.” 

Franchise  an  Important  Matter. 

Another  characteristic  which  differentiates  1 
them  from  other  corporations  is  their  franchise 
privilege  for  operation.  In  a wide  sense  steam 
railroads  are  franchise  corporations,  yet  their  t 
different  position  makes  it  practically  possible 
to  ignore  that  point  in  considering  their  bonds. 

The  franchise  with  public  utility  corporations 
is  a most  essential  consideration.  Their  char- 
ters are  obtained  from  their  respective  States 
and  define  their  rights,  duties  and  privileges. 

A franchise,  that  is,  a right  to  serve,  is  granted 
them  to  carry  on  certain  operations  within  the 
community  they  serve.  There  is  absolutely  no 
uniformity  in  this  matter  of  franchise.  Every 
State  has  its  own  laws  in  regard  thereto.  In 
Illinois  there  is  a law  that  no  franchise  can  be 
granted  for  a longer  term  than  twenty  years ; 
while  perpetual  franchises  have  been  obtained 
by  many  companies,  it  is  customary  to  limit 
the  number  of  years  a franchise  may  run,  its 
maximum  duration  varying  with  different  * 

6 


States  and  different  companies.  The  granting 
of  a perpetual  franchise  or  even  one  for  a long 
period  of  years  often  becomes  a virtual  monop- 
oly for  the  company.  By  its  franchise  the  com- 
pany becomes  intrenched  upon  the  principal 
thoroughfares,  works  its  way  into  the  desir- 
able localities,  and  if  it  renders  a service  con- 
sistent with  the  needs  of  the  community  is 
likely  to  be  granted  a renewal  of  its  franchise 
on  favorable  terms. 

Franchise  and  Monopoly. 

The  exclusive  privilege  of  using  streets  for 
railways,  for  poles  and  wires  for  distribution 
of  electricity  or  for  the  stringing  of  telephone 
wires  to  all  practical  purposes  is  a legal  monop- 
oly. It  is  being  recognized  more  and  more  that 
competition  is  undesirable  in  the  matter  of 
public  utilities.  Experience  has  proven  that 
where  franchises  have  been  granted  to  install 
a second  system,  the  public  and  the  companies 
have  suffered.  New  York  State  has  its  Public 
Service  Commission.  On  the  question  of  com- 
petition its  position  is  that  as  long  as  a com- 
pany is  serving  the  community  adequately  at  a 
fair  rate  it  will  not  permit  another  to  come  in. 

I n addition  to  its  length,  its  scope,  the  terms 

7 


and  conditions  of  its  renewal,  its  limitations,  if 
any,  etc.,  the  value  of  a franchise  must  be  con- 
sidered from  the  viewpoint  of  the  relation  of 
the  company  with  its  public  and  with  the  po- 
litical situation.  Close  affiliation  with  politics 
is  undesirable ; and  there  must  be  harmonious 
relations  between  the  company  and  the  people. 
Although  it  is  practically  impossible  to  revoke 
a franchise  where  its  terms  and  conditions  are 
being  met,  it  is  possible  through  taxation,  leg- 
islation of  one  kind  or  another  in  regard  to 
fares,  transfers,  etc.,  to  strike  at  a company 
which  has  incurred  the  hostility  of  the  people. 
A perpetual  franchise  is,  of  course,  best  for  an 
investor  in  the  company’s  bonds.  Where  the 
limited  franchise  exists,  a sinking  fund  should 
take  up  some  of  the  bonds  each  year;  and  as  a 
general  principle  the  issue  should  mature  be- 
fore the  set  date  of  expiration  of  the  franchise. 
There  is  a growing  sentiment  in  favor  of  the 
limited  franchise.  Perpetual  privileges  so 
largely  unrestricted  as  have  been  given  to  cor- 
porations are  becoming  fewer  and  fewer.  The 
whole  question  of  franchise  is  broad,  interest- 
ing and  important  and  is  one  on  which  hinges 
much  of  the  value  of  this  type  of  bonds. 

8 


Geographical  and  Commercial  Considerations. 

Other  factors  that  make  for  strength  or 
weakness  in  these  bonds  differ  with  the  nature 
of  the  company.  Considering  an  electric  inter- 
urban  railroad  as  a utility  corporation,  there 
is  the  importance  of  the  cities  which  form  its 
termini  upon  which  much  dependence  is  placed 
for  traffic ; also  the  character  of  the  intermedi- 
ate towns.  Their  geographical  and  commercial 
importance  should  be  considered.  If  the  line  is 
a connecting  link  between  some  large  city  and 
its  suburbs,  it  is  likely  to  prosper  from  the  be- 
ginning. Connecting  two  smaller  towns  in  the 
outer  country  much  more  uncertainty  of  its 
complete  success  exists.  With  the  purely  ur- 
ban or  street  railway  it  is  desirable  that  it  be 
located  in  a larger  city  where  there  is  a density 
of  traffic.  Some  bankers  consider  a population 
of  100,000  as  a minimum  for  perfect  safety  of 
the  securities  of  such  lines.  No  hard  and  fast 
rule  can  be  laid  down,  however.  With  either 
type  of  road,  population  served  is  the  deter- 
mining influence  on  the  character  and  service 
and  growth  of  earnings.  In  the  engineering 
estimates  for  the  building  of  such  lines  great 
l care  is  exercised  to  arrive  at  data  that  is  fully 

9 


* 


reliable.  Account  must  be  taken  of  the  growth 
of  the  city  and  the  crowding  from  the  city  into 
the  suburbs. 

Physical  Valuation  of  Plant. 

The  value  of  the  property  of  any  public  ser- 
vice corporation  must  be  regarded  in  consider- 
ing its  securities.  Before  bankers  will  buy  the 
bonds,  an  appraisal  is  made.  Expert  engineers 
are  sent  over  the  property  to  examine  real  es- 
tate, plant  and  equipment,  to  determine  what 
is  approximately  a replacement  value,  that  is, 
for  what  amount  the  whole  outfit  could  be 
duplicated.  If  the  bond  issue  is  less  than  that 
figure,  the  bonds  are  in  a strong  position,  jbut 
if  the  issue  is  in  excess  it  indicates  that  good- 
will, franchise  rights,  etc.,  have  been  capital! zed 
to  some  extent.  The  value  of  these  things  is.,  of 
course,  difficult  to  represent  in  figures,  andl  it 
is  the  bankers’  judgment  that  largely  decides 
whether  or  not  a conservative  figure  has  been 
used.  Where  a new  proposition  is  under  c on- 
sideration, there  is,  of  course,  a good  reason  Jor 
demanding  that  the  first  cost  be  considerably 
more  than  the  bond  issue,  since  there  is  no  in- 
dex of  earning  power  in  addition  to  actual 
value,  on  which  to  base  judgment. 

10 


Because  of  the  peculiar  nature  of  much  of 
the  property  of  electric  light,  gas  and  water 
power  plants,  in  that  it  consists  of  wire,  pipe 
and  more  or  less  machinery,  some  investors 
hesitate  to  take  bonds  of  such  companies.  Such 
^ people  do  not  regard  transmission  wire  and  ap- 
paratus as  an  excellent  basis  of  security. 

Depreciation. 

i The  value  of  the  physical  property  is  not  the 

*>nly  measure  of  worth  of  such  securities,  be- 
cause eventually  earnings  is  the  criterion.  A 
plant  in  a desirable  locality,  if  properly  man- 
aged, should  produce  good  returns;  and  it  is 
not  at  all  unlikely  that  foreclosure  on  such  a 
plant  would  bring  a price  greater  than  the  so- 
called  replacement  value.  A complete  analysis 
of  a public  utility  concern  involves  a thorough 
investigation  of  its  physical  condition,  financial 
operation  and  political  associations.  A con- 
sideration of  the  first  touches  on  the  matter  of 
depreciation.  What  may  be  said  of  industrial 
corporations  applies  here  also ; and  that  is  that 
no  rule  can  be  laid  down.  It  is,  however,  con- 
sidered good  practice  to  allow  somewhere  near 
ten  per  cent,  of  gross  earnings  for  this  item,  at 
* least  for  street  railways.  A gas,  telephone  or 

11 


lighting  plant  may  not  require  this  amount  in 
every  instance,  although  it  is  well  to  use  it. 
The  deterioration  of  plant  and  equipment  is 
rapid.  Only  by  a liberal  allowance  for  its  up- 
keep can  a true  statement  of  its  condition  be 
gained  and  efficiency  maintained. 

Contingencies. 

One  of  the  elements  of  risk  in  purchasing 
bonds  of  a street  railway  in  a small  community 
is  the  danger  of  accidents.  One  accident  of 
serious  proportions  with  its  resulting  damage 
suits,  were  they  successful,  might  impair  its 
financial  position  and  cause  much  difficulty  in 
meeting  its  obligations. 

Good  Record  of  Bonds. 

The  record  of  public  utility  bonds  as  a class 
is  not  marred  by  any  great  amount  of  default 
or  difficulty  of  any  kind.  These  companies 
have  shown  an  excellent  record  during  periods 
of  general  business  depression,  having  passed 
through  the  trying  times  unaffected  to  any- 
thing like  the  degree  that  steam  railroads  have 
been.  These  bonds,  therefore,  enjoy  a certain 
advantage. 

The  record  of  earnings  of  public  service  cor- 
porations during  periods  of  business  depres- 
12 


sion  tend  toward  stability  even  to  a greater  ex- 
tent than  is  the  case  with  railroads.  Where 
steam  railroads  have  suffered  a reduction  of 
earnings  from  ten  to  twenty-five  per  cent.,  the 
earnings  of  these  public  utility  corporations 
have  shown  but  a moderate  decline.  This  sta- 
4 bility  no  doubt  lies  in  the  fact  that  the  need  of 
their  services  is  imperative  in  a large  sense. 
They  supply  things  which  the  public  cannot 
* very  well  dispense  with.  Their  operation  is  a 
public  necessity  and  the  nature  of  their  busi- 
ness is  such  as  to  make  them  largely  inde- 
pendent of  the  periodic  fluctuations  in  general 
business  and  industrial  conditions. 

Capitalization  of  Utilities. 

The  bonds  of  a street  railway  ought  to  be  a 
security  of  high  value  providing  the  company 
is  not  over-capitalized.  Where  this  evil  of 
over-capitalization  exists  it  is  one  which  has 
grown  largely  out  of  the  consolidations  effect- 
ed in  large  cities  where  a number  of  indepen- 
dent lines  were  joined  and  welded  into  one  sys- 
tem. The  bonds  ought  to  be  a good  invest- 
ment where  the  company  has  a satisfactory 
franchise,  one  that  is  not  hedged  about  by  too 
many  restrictions,  does  not  expire  too  early 


l 


and  is  not  onerous.  Furthermore,  such  securi- 
ties ought  to  be  desirable  where  the  company 
serves  a comparatively  large  community.  Sta- 
tistics prove  that  the  securities  of  street  rail- 
ways operating  in  cities  of  fair  size  are  becom- 
ing better  each  year  with  the  development  of 
these  cities.  New  York  City  lines  have  been 
a notable  exception  to  this  statement,  but  their 
difficulties  have  been  attributable  to  what  has 
already  been  mentioned,  a burden  of  tremendous 
capitalization,  a large  part  of  it  unwarranted. 
The  earning  power  of  such  companies  is  an 
established  fact  where  the  proper  conditions 
exist.  It  has  passed  much  beyond  the  experi- 
mental stage.  There  is  every  indication  of  a 
steady  growth  of  population  in  important  cen- 
ters. The  trend  of  traffic  is  toward  the  cities, 
and  where  interurban  lines  connect  cities,  that 
condition  is  all  the  more  pronounced. 

Earnings  and  Expenses. 

The  statistics  also  show  that  the  ratio  of  in- 
crease of  earnings  of  these  companies  is  even 
faster  than  that  of  the  population.  The  ratio 
of  operating  expenses  to  the  gross  income 
varies  altogether  with  conditions.  All  avail- 
able data  points  to  the  fact  that  street  railways 
14 


in  cities  of  from  100,000  to  $00,000  require 
about  55  per  cent,  of  gross  earnings  while  a 
greater  population  means  an  increase  of  these 
expenses.  This  is  due  to  the  fact  that  up  to  a 
certain  density  passenger  traffic  of  this  charac- 
ter  may  be  handled  expeditiously ; beyond  that 
it  becomes  a hindrance  and  is  more  difficult  to 
move.  Cities  of  25,000  or  under  in  population 
show  operating  expenses  of  about  70  per  cent., 
25,000  to  100,000,  60  per  cent. 

Utilities  Well  Established. 

Considering  gas,  electric,  water  and  water- 
power companies,  it  is  obvious  that  each  has 
important  economic  functions  in  a community. 
The  electric  light  and  power  industry  is  grow- 
ing by  leaps  and  bounds.  Electricity  is  rapidly 
becoming  the  prevailing  illuminant  and  is  as 
rapidly  being  installed  for  power  purposes* 
Where  it  is  generated  by  large  water  power, 
as  at  Niagara  Falls,  it  is  usually  much  more 
economical  than  steam  power.  In  twenty-five 
years  the  lighting  and  power  industry  has  ad- 
vanced so  greatly  that  it  is  now  on  a permanent 
and  stable  basis.  Although  gas  has  been  sup- 
planted as  an  illuminant  in  no  small  measure, 
it  now  has  a new  use  compensating  for  the 
15 


loss.  The  adoption  of  gas  as  fuel  for  cooking 
has  become  widespread.  In  view  of  this  in- 
creasing use  it  is  more  of  a necessity  than  ever. 
The  demand  is  constant  and  ordinarily  in- 
creases with  the  increase  in  population.  In 
moderate-sized  towns,  the  debt  of  such  a com- 
pany should  bear  a proper  relation  to  the  cost 
of  the  plant. 

It  is  economical  and  of  instant  use.  Its  con- 
venience has  commended  it  so  that  enormous 
numbers  of  gas-using  appliances  are  constant- 
ly being  installed.  The  gas  industry  is  nearly 
a century  old,  and  for  all  the  competition  of 
electricity,  is  an  industry  whose  bonds  when 
well  selected  are  of  great  stability.  The  tele- 
phone business,  although  of  a different  charac- 
ter, has  now  entered  the  final  stage  of  its  ca- 
reer, the  stage  of  investment.  Financially  con- 
sidered, the  earlier  phases  of  this  business 
were  the  experimental  and  speculative  state, 
and  the  construction  stage  where  as  now  the 
telephone  business  is  on  an  investment  basis. 
A recent  issue  of  American  Telegraph  and 
Telephone  bonds  which  so  rapidly  found  pur- 
chasers here  and  abroad  bears  witness  to  this 
fact. 


16 


I . 

\ 

* 

I 


i 


